Positioning

The group’s financial services division consists of two independent businesses:

• FG Financial Services manages the group’s in-store credit card programme that consists of 14 different card formats. Included in this division’s responsibilities are the group’s Club, insurance products, cellular phone operations and customer relationship management.
• RCS Group provides a range of broader financial services to customers of the group and to customers of unrelated retailers. At present the financial products provided comprise RCS Personal Loans, RCS Cards, RCS Private Label Cards and RCS Home Loans. Standard Bank holds a 45% interest in this business. The RCS Group’s divisional report is found elsewhere in this document.

The positions of these businesses in the group structure are represented graphically below.

FG Financial Services

Review of the year

The past year has seen tremendous changes to the credit landscape. In June 2007 the National Credit Act (NCA) became effective, and it has had a significant impact on the way credit is advanced to customers.

The group chose to convert its entire base to operate under the framework and regulations of the NCA. Correspondence to this effect was sent out prior to 1 June 2007. This enabled the division to have a single standard for dealing with all customers and also afforded customers the protection that the NCA offers.

In the same process customers were evaluated in terms of their credit facilities and in some instances these facilities were increased, although customers had no access to this increased facility until their risk profile enabled the division to release the increased amounts.

During a period of several months preceding 1 June 2007 many players in the industry made substantial amounts of credit available to customers. This had the effect of boosting trade for these entities over this period, but some consequences are currently finding their way into the bad debt numbers. The approach adopted by the division was prudent and certainly its bad debt experience appears to have been better than that of the peer group.

The advent of the NCA had a negative impact on customers who wanted credit but did not qualify for it. The NCA affordability test resulted in a further 6,7% of credit applications being rejected in the division’s system.

The year also saw four interest rate increases and the repo rate consequently moved from 9,0% to 11,0%. This, coupled with inflation in the cost of food and fuel, has placed a heavy burden on many customers. High levels of indebtedness continue to be seen.

An examination of the payment behaviour of customers seems to indicate that whilst their collective behaviour scores at the bureaux are deteriorating, the same customers have stable behaviour scores with the group. This fact supports the conclusion that the division’s debt management practices are yielding good results.

Concerted efforts have been applied to prevent a build-up of arrears in the debtors’ book. During the course of the year, in anticipation of increased defaults, the division added capacity to its collections department by increasing the number of collectors and also applying dialer optimisation features. A great deal of emphasis was also placed on early-stage default, with good results. Strategies within our debtors’ decisioning system, TRIAD have been optimised to ensure that the division is effective in this area.

At the year-end arrears were up by only 0,3% on the previous year. Current trends suggest that the division’s recent efforts are paying off and the book continues to remain in a healthy contractual state.

Net bad debt grew by 15,7% compared to overall net receivable growth of 8,0%.

Interest income

The Foschini Interest Rate, which is applied to customer accounts, was kept below the maximum usury rate, and hence well below the maximum permitted under the NCA, despite the fact that customers are operating in accordance with the NCA. During the course of the next year an examination of risk-based pricing will take place and it is likely that there will be a move to differential interest rates, giving a slightly better rate to those customers whose payment performance has been correct and on time.

Other income

Insurance

Profit in this area grew by 46,4%, aided by some non-recurring items. By the year-end two additional insurance products had been developed and have been offered to the customer base since 1 April 2008. These products have been well received and will generate positive results.

Club

The Club grants a range of benefits for subscribers who are holders of the group’s credit cards or those of the RCS Group.

These benefits include:

• automatic death insurance;
• account balances protection;
• medical and legal helpline;
• qualification in the monthly R300 000 draw;
• discounts at several retailers;
• promotional item discounts;
• bursaries to the value of R2 million per annum; and
• a monthly magazine with topics of interest.

Currently there are more than 910 000 paying subscribers of the Club and 85 000 of the SuperClub.

The division’s relationship with Safika Highbury Communications has led to a step-up in the quality and content of the Club’s magazine and a very good response has been recorded from customers when surveyed about the magazine.

Following from a point made in last year’s report about other niche Club offerings, a new Sports Club together with an associated magazine will shortly be launched and initial consumer research indicates that a strongly positive response to this initiative will be forthcoming.

Profit from this area grew by 49,2%.

Cellular

Under the economic pressure that prevailed, cellular sales lost momentum and turnover rose by a modest 1,8%. The group’s exclusive arrangement with MTN continued. The product range is being continually reviewed and all procurement is now overseen by the division.

ONE2ONE

One2One was established in the 2007 year with its first product being the One2One Top-up Airtime Deal. This product grew in the past year and has clearly found a niche in the market. It is a discounted airtime offer sold through telemarketing and provides the convenience of an airtime contract linked to a group credit card. The rates to customers are better than those for standard prepaid airtime and the customer also benefits from a significant discount to conventional retail pricing.

Revenues grew by 188,8% for tre are expectations that still greater market penetration can be achieved by means of better customer selection, with a strong contribution to the division’s profits.

Net bad debt

In the collection process the division’s focus has continued to be on the earlier stages of default. This approach, coupled with the division’s hybrid contractual/recency collections policy, has seen collections continue to stay within acceptable ranges. Behavioural scores were evaluated during the year to ensure that they rank-order accounts correctly according to value and risk. The division’s scorecards were found to be highly predictive when measured against industry standard scorecards.

Write-off policy on bad debt remained consistent with the previous year. Non-performing accounts, defined as accounts whose payment profile scores and recency fall below fixed criteria, are written off monthly.

New applicant fraud

The forensic unit of the division had a very busy year, with high volumes of fraudulent applications being encountered. ID theft and impersonation have been exploited by crime syndicates. Database analysis tools used by the division have allowed it to keep the incidence of fraudulent applications below an internally recognised threshold of 3%. All new accounts continue to be passed through fraud profiling scorecards and database tests, with exceptions being referred to forensic underwriters.

Provisions

The division continues to use the Markov model to identify inherent risk within its database. Markov relies on 12-month default roll rates and predicts which accounts are likely to proceed to write-off. This information is used to create a provision for doubtful debts. In the past year the Markov model required a R25,9 million charge to the income statement as against R29,0 million last year. The doubtful debt provision now stands at R220,7 million, which represents 8,4% of the closing book compared to 8,0% of the closing book in the previous year.

Net bad debt to credit transactions increased to 3,5% from the previous year’s 3,0%**. Net bad debt write-off to debtors increased to 8,3% from the previous year’s 7,4%**.

Credit costs

Credit costs increased by 11,6% in the year. The factors influencing this increase were an investment in systems to contend with the NCA, as well as marketing expenses related to invitational mailings.

Strategy

A good level of success has been achieved in providing value-added products to customers. Having done this, the division, like other retailers, now faces the challenge of achieving growth in its customer base.

The response to this challenge lies to a great extent in optimal use of the group’s national presence and the number of different offerings across the group. It will also be necessary to increase product cross-shopping across the various chains within the group, and with this in mind a customer relationship management programme has been initiated. This will be headed by a senior executive transferred from a trading division. By exploiting the analysis capabilities which have been built up in the analytics unit of the division, the team headed by this executive will be able to seek out opportunities to increase the customer base and increase the group’s share of customers’ wallets while satisfying customers that they are receiving added value by shopping at the group’s chains. Some products that can be sold on a direct basis are also being investigated.

In the past year a sizeable proportion of customers indicated a preference for repaying their accounts over extended periods. They will now be accommodated by the group’s introduction of a 12-month plan as a default option (although a 6-month facility can still be chosen by both existing and new credit customers). During the course of the next year customers will have the option of moving to the full 12-month facility. This exercise will bring relief to some customers in that they can lower the amounts of their instalments, while others can raise the total of their purchases while still paying the same monthly instalments. This should have a stimulatory effect on sales throughout the group.

Prospects

Despite the present economic downturn and some negative sentiment in the market, the division’s objectives will be the continued efficient management of debtors and the achievement of growth in the customer base. If these objectives can be attained they will provide a meaningful contribution to the group’s overall performance.

The RCS Group

The RCS Group is a majority-owned but operationally independent division which provides a broad range of financial services to customers of the Foschini group and also to customers of unrelated retailers.

The RCS Group consists of three separate business units named Transactional Finance, Fixed Term Finance and Other Investments.

The Transactional Finance unit is a card business made up of two sub-units, one providing a general-purpose credit card known as the RCS Card, and the other sub-unit being concerned with private label card programmes.

The Fixed Term Finance unit also comprises two sub-units, known as RCS Personal Loans and RCS Home Loans.

The Other Investments unit is at this stage limited to holding 60% of the shares in Effective Intelligence (Pty) Limited, a data intelligence company.

Whilst there is a degree of commonality in systems and some sharing of operational resources, the business units are functionally separate and have their own fields of operation, management teams, budgets and profit models. The decision to differentiate the businesses was taken at the establishment of this division in 1999 in order to ensure that the Foschini group’s focus on its traditional trading activities was not lost, and that all profits and costs associated with this division were clearly ring-fenced.

Review of the year

The weakening economic conditions which prevailed in the second half of the past year took their toll on the RCS Group and the outcome was a decline of 19,7% in profit before tax.

Factors leading to this decline were:

• an over-generous supply of consumer credit by many credit suppliers in a period preceding the implementation of the National Credit Act (NCA) on 1 June 2007 – what has become known as the pre-NCA Gold Rush;
• a significant pull-back in credit purchases after 1 June 2007 coupled with generally unfavourable market conditions;
• the removal by the NCA of artificial regulatory barriers, resulting in credit market convergence and margin-shaving by credit suppliers under heavily competitive conditions;
• the effect of rising inflation on consumers’ budgets for living expenses;
• interest rate increases of 4,5% over the previous two years, eroding customers’ spending power and squeezing product margins;
• a significant worsening in patterns of payment by credit customers across the whole market; and
• increased collection costs to combat payment defaults stemming from some of the factors mentioned above.

Despite the setbacks it inflicted, the past year opened up various opportunities for the RCS Group to diversify its operations and make significant investments in infrastructure. Major investments were made in:

• personnel for the management team, both executive and operational;
• premises leased to allow the division to consolidate its operations at a single location;
• data warehouse and business intelligence systems; and
• strategic investments in the form of the acquisition of Effective Intelligence (Pty) Limited.

During the year the RCS Group moved further towards its goal of becoming a fully-fledged South African consumer finance business by expanding its product range, improving its solid business platform and enhancing its infrastructure.

Transactional Finance

The RCS Cards unit has undergone spectacular growth as a result of changes made to its business model in 2006 which led to greater support by merchants. The general-purpose RCS Card is now accepted in the businesses of more than 7 500 merchants nationally across various industries. Thus the unit’s cardholders have better utility than before.

The Private Label Cards unit, which continues to be a strategic growth business, again grew the number of customers and turnover in the Queenspark portfolio above expectations. The credit operations of Massdiscounters (MDD), which were acquired in the course of the year, will be a significant addition to the private label card operations. The acquisition is awaiting final approval from the competition authorities.

Review of the year

Merchant turnover through our cards in the past year was R1,36 billion (2007: R1,14 billion). In the current market this is a significant achievement.

The introduction of a single-format card with lower merchant commission rates in August 2005 has had an extremely positive impact on merchant acceptance and consequently on turnover through the card. The wider acceptance has also lifted the number of new accounts, the active base rising to 435 000 (2007: 366 000). The RCS Card continues to make inroads into the broader card market.

Revenue growth was strongly positive as a result of better product pricing, robust book growth over a three-year period and increased credit turnover.

Net bad debt cost increased significantly as a result of the lagged effect of strong book growth since 2005. Arrear debtors have increased to 29,1% (2007: 20,3%) of the portfolio. This reflects the effect of adverse market conditions and the continuing upward trends in interest rates and levels of indebtedness, with the excessive credit granted by some lenders before the implementation of the NCA also playing a role. This increased risk has been covered in the increased provision made on the portfolio. It is, however, expected that debtor statistics will normalise in the next year.

Credit costs have been contained at less than revenue growth. Increased costs arose mainly from collection costs and from investment in key skills and infrastructure. Further investments in skills and infrastructure are still being made to enable the unit to provide superior service to its merchants and customers.

Tight control was exercised on direct costs under the unit’s control and as a result the cost-to-income ratio decreased to 34,1% (2007: 35,2%).

Prospects

Credit turnover is expected to rise despite current tough trading conditions. This should lead to continued healthy book and revenue growth. Although bad debt growth can be expected to remain high during the coming year, rising revenue coupled with strong cost control should result in satisfactory performance in the future.

The unit is well positioned to utilise new channels and to add to existing private label programmes. The business model fundamentals are therefore in place to provide sustainable profit growth over the longer term.

Fixed Term Finance

This unit provides personal loans to customers of the Foschini group and to others. Customers are attracted by the convenience and simplicity of the RCS personal loan offer, with a large part of the process being handled telephonically. The high level of repeat loans attests to the appeal of the loan model.

The selection criteria for loan applicants remain strict, whilst response modelling has been improved. The unit’s challenge in the next year, when tough trading conditions are again expected, will be to balance volume growth with product profitability and credit risk.

Review of the year

RCS Personal Loans’ profit before tax has been hampered by higher bad debt provisions, increased bad debt write-offs and pressures on product margin stemming from increased cost of borrowings and higher collection costs.

Net interest revenue declined as a consequence of the smaller debtors’ book and increased borrowing costs. Interest hedging mitigated some of the higher borrowing costs. Other income increased as a result of some pricing adjustments to fees after the implementation of the NCA.

Arrear debtors increased to 14,3% (2007: 8,6%) of the portfolio. The factors which affected this unit’s bad debt position are similar to those experienced in the Transactional Finance unit referred to above. The increased risk of default has resulted in increased amounts for bad debt provisions and write-offs.

Credit costs increased by 27,5% mainly as a result of higher collection costs and the unit’s investment in key skills and infrastructure. Tight control was exercised on direct costs under the unit’s control. As a result, the cost-to-income ratio remains acceptable at 31,6% (2007: 24,8%) when taking into account the lack of book growth and the significant investments made during the past year.

All key debtor statistics were affected by the lower debtors’ book, the reduction in its size resulting mainly from lower credit advances after the implementation of the NCA. Taking into account the lower levels of advances and debtors’ book growth the rise in key debtor ratios remains in line with current market trends.

Prospects

The Fixed Term Finance unit remains a profitable business with significant growth opportunities. Before the implementation of the NCA the fixed-term loan offer was capped at R10 000 in amount and 36 months in duration. By utilising some of the post-NCA opportunities and after conducting extensive market research, the unit launched a new personal loan product during the last quarter of the 2008 year. Some of its features are:

• a longer term (capped at 60 months);
• a higher amount (loans in excess of R10 000); and
• flexible risk-based pricing to compete in wider market segments.

This product should allow the unit to increase credit advances and grow the debtors’ book in the next year. High levels of recoveries are also expected because of write-offs in the past, an improvement in the arrears position in the coming year and a better risk mix among customers for the new product.

This will have a positive impact on the new year.

New Ventures

The RCS Group made an acquisition of 60% of the shareholding in Effective Intelligence, a data intelligence company. Although this acquisition was strategic in nature, its profits, whilst not material for the group, exceeded expectations.